Capital and liquidity ratios and financial distress. Evidence from the European banking industry

Using a large bank-level dataset, we test the relevance of both structural liquidity and\r\ncapital ratios, as defined in Basel III, on banks' probability of failure. To include all relevant\r\nepisodes of bank failure and distress (F&D) occurring in the EU-28 member states over the\r\npast decade, we develop a broad indicator that includes information not only on bank-\r\nruptcies, liquidations, under receivership and dissolved banks, but also accounts for state\r\ninterventions, mergers in distress and EBA stress test results. Estimates from several ver-\r\nsions of the logistic probability model indicate that the likelihood of failure and distress\r\ndecreases with increased liquidity holdings, while capital ratios are significant only for\r\nlarge banks. Our results provide support for Basel III's initiatives on structural liquidity and\r\nfor the increased regulatory focus on large and systemically important banks.